First, it was the Greek tragedy and now investors are wondering what might be the next domino to fall in an increasingly tangled web of deficits. Since the end of January, the U.K. pound has lost six percent against the U.S. dollar and four percent against a wobbly euro. Credit-default swaps, a form of financial insurance for government bonds, has risen dramatically for 47 of the 50 countries for which these instruments are listed.

The financial press has been buzzing lately with increasingly shrill commentary about the problems plaguing Greece spreading far beyond its borders. “A Greek crisis is coming to America ” was the headline in a recent Financial Times article that argued that Greece is the start of a much bigger problem.

Jittery investors have been speculating about which country could be next in line to experience severe debt problems. Most of the speculation so far has surrounded Spain , Portugal and Ireland—highly indebted countries on the periphery of the euro zone. But the United Kingdom and the U.S. are also a worry. Forecasts from the IMF have pegged the U.K. 's 2010 deficit to GDP at 13.2%—the highest in the G20 group of big countries. And the build up of debt in the U.K. only appears to be accelerating and by 2014 total debt as a percentage of GDP will be second only to that of Japan.

No doubt, the stakes are very high. A total loss of confidence in the government bonds of any of the major European powers or in America would sound the death knell of this fragile economic recovery. If lenders lost faith in the fiscal discipline of a major borrower, such as the United States , the costs would be immense. Lenders would demand greater compensation for the risk they are assuming, which in turn would cost governments around the world, billions in additional interest payments.

To the pessimists, the situation is grim. Public debt often soars dramatically after a financial crisis, as the government steps in as the spender of last resort. According to a study by Carmen Reinhart and Ken Rogoff, public debt rises by 86 percent on average after a financial crisis. Making matters worse, no major Western economy is running a tight enough budget, nor posting solid enough economic growth to avoid increasing their debt burden.

Most of the highly indebted rich countries in the West face an ageing population and soaring health and pension costs. If the economic recovery does take root, then interest rates are likely headed higher from here. The average maturity on U.S. government debt is just five years, so rising interest rates would quickly translate into bigger interest payments and a worsening fiscal position.

Much of the recent concern has been focused on the sheer scale of America 's public debt and China 's role in funding it. America is the world's biggest debtor and China is America 's largest creditor. For some it's only a matter of time before the Chinese throw in the towel on America , as its proliferate ways must surely lead to a decline in the dollar. Last December, demand for American treasuries fell sharply and it was rumored that Beijing was a big seller of U.S. treasuries—a worrisome development.

But in spite of these concerns, the yield on U.S. treasuries has remained low. Optimists point to the fact that America 's benchmark securities are a safe haven investment in a troubled world and that should help keep interest rates low. They also argue that there is likely to be little competition from the private sector for capital as firms and households rebuild their finances after the crisis. Optimists also make the point that China has no incentive to drive down the value of the U.S. dollar with a fire sale of their holdings.

While America is still considered a safe haven, the Greek tragedy illustrates how quickly investor sentiment can change. America, unlike Japan, relies much more on foreign investment to fund its budget. But as emerging markets continue to develop their economies and reorient themselves towards domestic consumption, the pool of available savings in countries such as China will shrink.

The best opportunities for investors continue to be in the emerging markets, or the countries that supply the commodities that are so crucial for the ongoing industrialization of these countries. While a sovereign debt crisis in a major industrial power may be a long time in coming, slow economic growth and painful deleveraging for most of the West is the likely outcome for the next several years.

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